Monday, January 26, 2009

6 Ways CEBI Members are Taking Advantage of Market Turbulence

In more than one recent meeting of Chief Executive Boards International, members asked what others were doing to "make lemonade" out of a turbulent investing climate. As always, I'll remind you that anything you see on Chief Executive Blog or the Chief Executive Boards International site is an idea, not a recommendation. Consult your own financial advisor to be sure any strategy is right for you. Here's what our members said:

  1. Capture Unrealized Capital Losses -- This is a surprisingly little-understood strategy that's not all that hard. There are two important things to remember:

  2. A. Capital Losses can offset up to $3,000 of ordinary income in the year the loss is taken. Losses in excess of $3,000 can offset either short-term or long-term capital gains. And they can be carried forward indefinitely to offset future capital gains.

    B. The "wash sale" rule -- If you sell a security, you must wait 31 days to buy back into that same security, or it's ruled a "wash sale" -- as if it didn't happen at all.

    So, if you have stocks or mutual funds that are now worth less than you paid for them, you can sell them and capture those losses for 2009. But then what? Of course, you could sit on the cash for 31 days and then buy them back, which would be a good thing if the price goes down and a bad thing if the price goes up during the 31 days. Or you could just buy a different, and probably similarly depressed, stock in the same industry or mutual fund of the same style the same day. A simple plan if you don't mind changing horses.

    A more sophistocated plan for mutual fund investors who like the funds they're in could be to sell your "underwater" mutual fund shares (being careful to specify those original lots that are actually worth less than your basis), and then buy an Exchange Traded Fund (ETF) of the same class, on the same day. For example, sell a large-cap mutual fund and buy a large-cap ETF. Presumably, your favorite fund and the ETF would track each other relatively closely for a period as short as 31 days. On the 31st day, sell your ETFs and repurchase the same mutual fund. Any market variations in the meantime will either generate additional captured losses or gains that will be offset by the captured losses. And you won't suffer the potential risks of market timing -- being out of the market in case it soars upward while you're out.

    Perhaps the TV precaution "Don't try this at home" is appropriate. You may need an investment pro to execute this for you -- getting out of your mutual funds and into an ETF and back requires some technical savvy.

  3. Reallocate -- Some members feel the market, if not at its bottom, may be close enough. Those members are reallocating cash and fixed income assets back into equities (now that they're underweighted in equities due to their decline in value). The preferred way to do this would be dollar-cost averaging. Take the amount you want to reallocate and invest it over, say 5 or 10 installments. You could do that over 5 or 10 weeks, 5 or 10 months or 5 or 10 quarters, depending on your own assessment of the market. This way, you buy more shares if the price is lower and fewer shares if the price is hign. Discipline is important -- pick the same day of the week, month or quarter, hold your nose, and execute your plan.

    Right now, you may be at greater risk being out of the market than you are being in the market. History suggests that there will be single weeks of huge gains at the turn. If you're on the sidelines, you'll never catch up.

  4. Buy troubled assets -- If you have cash or credit lines (at record-low interest rates), you may be able to pick up equipment, inventory or real estate at prices you won't see again. One CEBI member said "I'm looking for vendors who need orders worse than they need margins." Some members are looking at second homes or income-producing real estate at "distress sale" values. As always, due diligence is everything. Consider hiring a your own pro's to assess, evaluate and appraise anything you're considering buying. And use your credit when doing so. An asset where you invest 20% cash that appreciates 20% is a 100% return on your invested cash, vs only a 20% return, had you paid cash for it. At today's interest rates on long-term financing, that would take a long time to break even in interest savings. Use other people's money where it makes sense for you.

  5. Free up cash from your least-productive asset -- your personal residence. Ron Wiley, the founder of CEBI once said "A house is not an asset -- it's a liability." And having owned six of them, I'm inclined to agree. This is perhaps the most emotionally charged strategy that surfaced, as some people take great solace in knowing "my house is paid for." Nothing wrong with that viewpoint. Others, however, see their house as simply part of their capital structure, just like any other asset or liability on their balance sheets.

    Considering that anyone with good credit can get cash out of this non-productive asset by refinancing for 30 years at 5% or less -- rates we may not see again in our lifetimes -- it's too compelling to not mention. If you just found another investment with a 5% return, it's a breakeven. And if you're generally invested in liquid assets, you'd have the comfort of knowing that if you had to, you could sell one of those assets and pay off the house again -- probably in less than 48 hours.

    There are potemtial AMT consequences to this strategy -- do proceed carefully. If you refinance and spend the money, of course, you lose the game.

  6. Free up cash from your business -- Many CEBI member companies are LLCs or S-Corporations. You've already paid taxes on a lot of money that's tied up inside your business -- it's on the balance sheet, usually as fixed assets, working capital or real estate. For the moment, long-term interest rates are at the lowest we'll see in a long time. The economy will pick up, and when it does, so will inflation, prices and investment interest rates. Some members are lining up long-term debt at today's bargain rates, pulling that cash out of their businesses (off the table -- you're protected from creditors and judgements by your corporate veil) and investing it in other things on their personal balance sheets.

  7. Do the math. Financially savvy people understand that a 5% debt and a 5% investment of the same amount are a wash. The return from the investment exactly covers the interest cost of the debt. If you can tilt that equation just 1 or 2 percent in your favor, you're making money in your sleep. When you're making investment decisions, if the opportunities and risks are similar, it's just about comparing the interest rate on a debt or the ROI on an investment.

  8. Do nothing. Probably the strategy of choice for most Americans right now, who seem to be paralyzed by the current economic climate. However, CEBI members are not most Americans, and are generally used to making the best of the cards that are dealt. Try 1 through 5, or something else that makes sense to you.
Remember, anything you see on this blog in an idea, not a recommendation. Consult your own financial advisor to be sure any strategy is right for you.

If you have current-economy business or investing strategies that aren't mentioned above, would you click "Comments" below and share them with others?

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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